Question 1

AIPIC is considering the purchase of new computer equipment and software to

enhance its graphics capabilities Management has been considering several

alternative systems, and a local vendor has submitted a quote to the company of

$15,000 for the equipment plus $16,800 for software. Assume that the equipment

can be depreciated for tax purposes over three years as follows: year 1, $5,000;

year 2, $4000; year 3, $6,000. The software can be written off immediately for tax

purposes. The company expects to use the new machine for four years and to use

straight-line depreciation for financial reporting purposes. The market for used

computer systems is such that AIPIC could sell the equipment for $2,000 at the end

of four years. The software would have no salvage value at that time.

AIPIC management believes that the introduction of the computer system will

enable the company to dispose of its existing equipment, which is fully depreciated

for tax purposes. It can be sold for an estimated $200 but would have no salvage

value in four years. If AIPIC does not buy the new equipment, it would continue to

use the old graphics system for four more years.

Management believes that it will realize improvements in operations and benefits

from the computer system worth $18,000 per year before taxes. AIPIC uses a 12

percent discount rate for this investment and has a marginal income tax rate of 40

percent after considering both state and federal taxes.

a. Prepare a schedule showing the relevant cash flows for the project.

b. Indicate whether the project has a positive or negative net present value.

c. calculate the profitability index

d. do think IRR would be above the 12% discount rate or blow